This is what the start of a bear market looks like.The S&P 500 struggled to a new high only
two days ago on low volume amid an abundance of non –confirmations.Investor sentiment is still high while the number
of new daily highs is lower on each successive rally.New highs reached 536 last May, 428 in
October, 362 in December and only 165 this month.A year ago 90% of S&P 500 stocks were
above their 200 day average, compared to only 72% recently.Margin debt is at record levels, both on an
absolute basis and relative to GDP.Small stocks are under pressure with the Russell 2000 down 10% this
morning only two days after the S&P 500 peak.

At the same time market valuations are at levels exceeded
only in 1929, 2000 and 2007, while Quantitative Easing is being steadily
withdrawn and will likely end in October.In addition there is mounting evidence from recent economic releases
that the economy has remained weak even after the cold winter weather subsided,
and that the hopes for a breakout to self-sustainability will be dashed as they
were in each of the past three years.The Eurozone economy, too, seems entrapped in a little or no growth
environment with 1st quarter GDP up a disappointing 0.2%.China, meanwhile, is attempting the
exceedingly difficult feat of slowing down their economy and dampening
excessive credit at the same time that they are trying to implement the long-term
goal of moving toward a consumer-led economy rather than one almost entirely
dependent on exports.

Despite the problems, most investors are in a state of
denial, looking to “buy the dips” in anticipation of a stronger recovery and
higher earnings that may not come to pass.This is all too typical of market tops, which typically take some time
to form.Generally, bear markets go
through three psychological phases----denial, concern and capitulation.The denial phase is the initial significant
downleg from the bull market high.During this phase the majority of investors are still in a bullish frame
of mind, after seeing continuing profits in their accounts, and having seen the
market bounce back from numerous previous corrections.They look upon the decline as merely another
buying opportunity and think that stocks are now bargains. In addition the
fundamentals during this phase are still perceived as positive and any negative
news is downplayed.Following this phase
the market usually rallies, but on weak breadth and lower volume.

Eventually, the market tops out well below its previous
high and starts a new downleg carrying it to lower lows.During this phase the fundamental news worsens
significantly and investors realize that a bear market is in force.This is the phase of concern.During this phase many investors sell, but
others hang in, feeling that the bad news is discounted and that a bottom is
near.At this point the market may rally
again as many observers feel the decline has ended and that a new bull market
has begun.This rally, also
characterized by weak breadth and low volume, subsequently fails and heads
down.

At this point the majority becomes exceedingly bearish
and throws in the towel, fearful of further declines and the potential disappearance
of their assets.This is the
capitulation phase, when stocks are sold on fear and emotion rather than on rational
analysis.It is at that point that the
market is finally ready to make an important bottom.

Obviously, the above description is a generalized outline
based on historical patterns, and never takes place in exactly the same
way.However, we think that it provides
a rough framework of what is likely to take place.

Currently, the market is still in its denial phase as
most investors seem to be staying with their bullish beliefs.The Investor’s Intelligence Survey is still
an astoundingly high 55% bullish and only 19% bearish, about the same position
it has been in for the last three months.From what we can determine, most investors still believe that economic
growth will accelerate and that market valuations are at least reasonable, if
not downright cheap.

We strongly disagree.
In our view the economy is continuing its tepid growth trend and the market is
significantly overvalued.Market tops
are a process that takes time to develop, and we believe that we are going through that process now. The downside risk remains high.